Real Money

Three Cash-Rich China Stocks

Here are three Chinese stocks that are trading near cash per share.

Obviously, in a valuation scenario like this, you're sometimes getting a business which has some issues. I liken it to getting a great discount on a used car vs. buying a full-priced new car. Even if you don't want the used car you can probably get a great resale value out of it since you got it at such a bargain price.

This is a trade that only works for me a few times a year and it takes a lot of patience, but right now there are a few stocks that are jumping out on my watch list that are trading near cash per share.

Unfortunately, the COGO trade already has started to pass us by. The stock trades at about $7 a share and has about $3.30 a share in cash. The stock recently traded as low as $5.49 in November and I was watching it every day, waiting for my target of "anything with a 4 handle." Since then COGO has bounced 35%. At this level, the stock is no longer a low-risk cash vs. market-cap trade, but it still looks cheap in terms of cash adjusted per-share earnings.

Google Finance shows the stock at a price-to-earnings ratio of 38, but this is incorrect. The 38, backward-looking P/E reflects two very ugly quarters - the fourth quarter of 2008 and the first quarter of 2009. But the company is largely back on track.

If Cogo Group continues with stable performance as it has done the past two quarters, it would place the stock on a forward P/E of only 5 times (if you expect $60 million in recurring net income vs. market cap of $265 million. Adjusted for cash means that even buying COGO at $7.37 results in paying only 2.5 times expected earnings.

I just bought HQS this week and I think it is a "no brainer" trade. At the current price of $7.07, HQS is trading at almost exactly the value of cash and receivables on its books. The company has nearly $100 million in cash and receivables, no debt and is profitable.

While the stock has had some ups and downs, it is on track to make around $12 million to $15 million in net income, according to my estimates, this year. That is about $1 a share. The way I think of it is that because the stock price is backed by 100% cash and receivables, I'm getting my dollar for free. The cash adjusted P/E on this type of trade is effectively zero.

In June, HQ Sustainable raised $12 million in an equity offering at $8.50 a share run by Roth Capital, so presumably there is a large group of institutional investors who already have done their homework. The deal was done prior to the close of the second quarter.

At the time of the deal, HQ Sustainable's first-quarterly earnings were only $1.1 million. Shortly after the deal, second-quarter earnings were announced at $2.2 million, double the previous quarter. Earnings for the fourth quarter came in at more than $4 million, again almost another double. In my way of thinking, if institutional investors were happy to buy this stock in June at $8.50 based on $1.1 million in previous quarter earnings, then I should be delighted to buy it now in the $7 range based on earnings of more than $4 million in previous quarter earnings.

This pattern of rising earnings but a falling stock price spells opportunity. It is identical to the pattern on COGO, but I was a bit too stingy in trying to pick my "in price" on COGO, so I didn't want to make the same mistake by missing out on HQS.

Another cash rich name is Acorn International, which just paid out $29.3 million in a special cash dividend to shareholders. This is clearly a great thing for long-term shareholders looking to realize value out of the stock. But for someone looking to do a quick cash vs. market-cap trade, the special dividend is a problem because it is taxable. Think of it this way, if XYZ trades at $10 a share, has $10 a share in cash and declares a $10 special dividend (giving away the whole company), you the investor just paid $10 for the stock but will get $8.50 back after taxes. Ouch.

In the real world, companies aren't going to give away the whole company, and there will be some math to do to evaluate the size of the dividend vs. the impact on the share price, etc. In any event, now that the dividend is paid the risk of a near-term subsequent dividend seems low and the valuation of Acorn still looks good.

Post-dividend, ATV has about $120 million in cash vs. a market cap of $143 million. As usual, a backward-looking P/E ratio tells us nothing. Acorn lost money in two of the last four quarters, so there is no meaningful P/E. But it looks as if ATV will have three profitable quarters this year.

If earnings come in at the mid-range between second-quarter and third-quarter results, Acorn will earn about $20 million this year implying a P/E of around 7 times. If you back out the cash (which is still at 80%-plus of market cap) you are really only paying 1 times this year's earnings. It's a nice deal while it lasts.

Please note that due to factors including low-market capitalization and/or insufficient public float, we consider COGO, HQS and ATV to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.